Pension - APG · pension, the provision of a basic pension will help to ensure that old-age poverty...

01 Ch Ch Ch Ch Changes

02 A view from the outside on Dutch Pensions 08 Proactive planning as the answer to consumer and labor market uncertainty in the Netherlands

18 Chilean insights for the Dutch pension debate

24 View from the UK

30 European Pension Plans

36 Insights from the outside

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June 2016

number 2

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APGGustav Mahlerplein 3

1082 MS Amsterdam

www.apg.nl

Pension

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Ch Ch Ch Ch Changes

As the new kid on the block, it is a very refreshing experience to be at APG at this juncture. These are times of change, not only for me changing jobs, but also for the whole pension industry. The pension sector is facing new challenges and opportunities. And of course, there will also be implications for the standing business of APG. Like in the David Bowie song cited above, the industry faces the strange. Never before were interest rates so low as at this point in time. The call for individual freedom of choice and flexibility is very present in the current debate due to the increasing numbers of self-employed people, the changing age composition of the work force and, last but not least, increasing longevity.

In the policy arena, policy makers are having an energetic debate to find answers to the challenges that the pension system is facing in the next decades. It is in this context that I am delighted to present this new edition of our flagship publication Pension.doc. Each article contributes to an open dialogue with pension experts, practitioners and policy makers within the Netherlands, but also brings the views of renowned experts on our pension system.

And to me their views give some remarkable insights. The contribution of Solange Berstein shows that the country with the most extensive experience on individual Defined Contribution pension products struggles with the adequacy and design of these pension products and is thinking about more solidarity in the pension system. Solidarity that also can be extended to the self-employed. The road to freedom

of choice seems to require very careful design and a strong focus on putting clients interests and needs first. Norman Dreger remarks that it is the question how to encourage people to work longer, because this would have the compounding effect of giving the individuals more years to accrue a pension, as well as less years of expected retirement. Focusing on how we ensure that older people remain working is a point well taken.

However, the pension debate should be a two way avenue. It is not only good that international experts provide a view on the Netherlands, but also that the Dutch pension funds look outside the Netherlands and share their technical knowledge with the rest of Europe. This has resulted in a critical view on the Pan-European Personal Pension Plan (PEPP) project, with comments that may open ways to improve the PEPPs–proposal, aimed at increasing pension adequacy for segments of the working population in many member states that do not save sufficiently for retirement.

As a final word, I would like to extend my special gratitude to Solange Berstein of the Inter-American Development Bank (IADB), Norman Dreger of Mercer, Chris Curry of the Pension Policy Institute (PPI), as well as to our own colleagues from APG, for their outstanding contributions to this edition of Pension.doc.

Gerard van OlphenCEO APG Group

P e n s i o n d o c . G O O D P E N S I O N D E S I G N

The authors

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gerard van olPhenCEO APG Group

1

norman dregerPartner and leader of Mercer’s Multinational Client Group in Central Europe (Austria, Germany and Switzerland)

2-7

marc heemskerkPension advisor and certifying actuary for a number of leading pension funds, Mercer Netherlands

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manuel garcía-huitrónStrategist APG

8-18

michiel van leuvensteijnStrategic Policy Advisor APG

8-18

chris curryDirector of the Pensions Policy Institute (PPI)

24-30

johan barnardHead of International Public Affairs, APG

30-36

wilfried mulderStrategic Policy Advisor, APG

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sandra PhliPPenIndependent economist and sociologist

36-40

alwin oerlemansChief Strategy Officer APG

8-18

solange bersteinPrincipal Expert Pensions, Inter-American Development Bank

18-24

P e n s i o n d o c . g o o d p e n s i o n d e s i g n 1

P e n s i o n D o c . G O O D P E N S I O N D E S I G N

A view from the outside on Dutch Pensions

The Dutch pension system is considered by many to be one of the greatest in

the world. In the 2015 Melbourne Mercer Global Pension Index (MMGPI), the

Netherlands was one of only two countries to receive the top available rating.

The high level of pension assets present, excellent coverage of the population

and good governance have all contributed to the robustness of the Dutch

pension system. Ongoing reforms and the courage to make difficult changes

to the system to keep it sustainable in light of demographic shifts have also

contributed to its success. This paper outlines the areas of strength of the

Dutch pension system, discusses some of the more recent changes to Dutch

pension law, and highlights additional areas for improvement.

NOrMAN DrEGEr

Partner and leader of Mercer’s Multinational Client Group in Central Europe (Austria, Germany and Switzerland). Norman is a member of the Swiss and German Management Teams and the EMEA International Consulting Leadership Group.

MArC HEEMSkErk

Pension advisor and certifying actuary for a number of leading pension funds, Mercer Netherlands.

2

background

The Netherlands has a multi-pillar pension system consisting of social security retirement benefits (pillar 1), company pension benefits (pillar 2) and private retirement savings (pillar 3).

Social security benefits are payable to all residents of the Netherlands, independent of how much they have contri-buted to the system over the years. The provision of such a minimum pension “safety net” ensures that all Dutch people will receive a minimum level of benefits in retire-ment, at least enough to be able to hopefully live out their lives in dignity.

As Social Security benefits are only intended to provide a minimum pension to all residents, most employers in the Netherlands also provide company pension benefits to their employees. Common plan designs and structures include defined benefit (DB) foundations, defined contribution (DC) foundations, insured DC plans, industry wide multi-employer plans, and a special Dutch invention, the Collective DC or CDC plan.

In a CDC plan, the pension scheme will target a benefit level, based upon an agreed set of assumptions, such as life-expectancy, investment returns, etc. However, if these assumptions are not borne out in practice, the benefits will ultimately be reduced. One could argue that this type of plan design combines many of the positive attributes of both a DB and a DC plan; it gives beneficiaries the ability to plan for their retirement based on clear expectations, while the employer does not bear the risk of adverse deviations to expectations and does not need to show liabilities in its balance sheet, as it would have to in the case of a DB plan.

Properties of an “ideal retirement system” and a comparison of the Dutch retirement system with these characteristics

All developed western nations are struggling with the same issues: Low economic growth, low birth rates, societies that are growing older and pension systems that are in many cases insufficiently robust to deal with the economic and

demographic challenges they will have to face in the coming years. So how should modern retirement systems be structured in order to best deal with these challenges?

Mercer, together with the CFA-Institute, prepared a study in 2015 entitled “Ideal retirement Systems.” A key purpose of this study was to analyse the characteristics of effective retirement systems and to identify best practice.

Among others, the following characteristics of an ideal retirement system were identified:1. High coverage within the private pension system2. Mandatory contributions of at least 8% of earnings3. 65 – 80% target net replacement rate for average earners4. Funded assets for the future of >100% of the country’s GDP5. A basic pension for the poor of at least 25% of average earnings

Given the Netherland’s top rating in the Mercer Melbourne Global Pension Index, it is not surprising to find that the Dutch pension system performs well against each of these five criteria:1. High coverage within the private pension system: The level of coverage of retirement benefits in the Netherlands is one of the highest in the world, with 88% of workers covered by a private second pillar pension scheme (Source: Ideal retirement Systems research). 2. Mandatory contributions of at least 8% of earnings:

According to the MMGPI research, the average mandatory contribution to a funded pension plan in the Netherlands is approximately 8%, thus meeting the criteria set out for an Ideal retirement System. 3. 65 – 80% target net replacement rate for average earners: The OECD publishes a report on pensions at regular intervals entitled “Pensions at a Glance”, in which pension systems in the OECD countries are compared and contras-ted. According to the latest OECD study, a median earner in the Netherlands will receive a net replacement rate at retirement of just over 100%, again making it one of the highest in Western Europe. To contrast this, in neighbou-ring Germany, a median earner will generally not attain the 65% net replacement rate target, and the Uk comes in at roughly only 69%. Thus while most developed societies worry about large groups of pensioners who cannot afford to retire, or who at the very least are unable

to maintain their lifestyle once they do retire, this problem is considerably less prevalent in the Netherlands. 4. Funded assets for the future of >100% of the country’s

GDP: One aspect that is examined in the MMGPI is to what extent assets have been set aside in order to pre-fund future pension obligations. According to the 2015 Global Pension Index, there were pension assets in the Nether-lands of approximately 160% of GDP. This high level of funding helps ensure that the intergenerational contract is adhered to. Other countries that rely more heavily on pay as you go financing may be in for a rude awakening as they find their populations aging, leaving an ever shrinking active population to pay for the benefits of an ever growing pensioner population, making their pension systems potentially unsustainable in the long run.5. A basic pension for the poor of at least 25% of average

earnings: The Dutch social security program provides a minimum pension at retirement, based on residency. For a married couple, each person would receive 9,481 EUr per year, for a single person the amount is 13,866 EUr (2015 figures). According to the Ideal retirement Systems research, the basic pension for a single low income pensioner in the Netherlands is approximately 30% of final earnings, making it one of the highest minimum pension benefits for citizens in Western Europe. Unlike some of its neighbours who do not have a minimum pension, the provision of a basic pension will help to ensure that old-age poverty will not be a wide-spread phenomenon in the Netherlands, as it otherwise would be.

Dutch pension reform: ensuring sustainability for many years to come

Part of the reason the Dutch pension system is one of the most robust in the world is the fact the government of the Netherlands has had the courage to make reforms to the system as necessary.

The reforms in the first pillar, the pay as you go social security system, were relatively straightforward to imple-ment. To ensure the sustainably of the system, the normal retirement age is in the process of being increased in stages from age 65 to age 67 in 2021. From 2021, the normal retirement age will be increased automatically based on improvements in life expectancy. Given that roughly half

of the total retirement income benefits paid in the Nether-lands come from the first pillar, these reforms will help to ensure that all citizens can expect to receive a reasonable basic pension from social security, for many years and hopefully generations to come.

Second pillar pensions, company sponsored pension benefits, account for roughly 40% of retirement income in the Netherlands. Benefits under this pillar are financed by employers and employees, with the government’s role being that of a supervisor and facilitator. Making reforms to second pillar benefits has historically been less straight-forward, and more controversial than making reforms to first pillar pensions.

Given that it is so often praised by those living outside of the Netherlands, it may come as a surprise to hear that many Dutch people are not happy with their second pillar pension system. In order to put this mistrust and discontent in context, one needs to realize that the Netherlands was traditionally a DB-pension market, in which for many years everything seemed to be working well. Thanks to an extended period of asset growth in the 1980s, 1990s and early 2000s, pension plans were generally well funded and were consistently able to provide voluntary features such as conditional indexing of pensions in payment. However, the financial crisis in 2008 introduced a new and challenging era for Dutch second pillar pensions. Suddenly little or no indexation of pension benefits was being granted, and some pension funds even needed to reduce the benefit entitlements of plan members. These events have led many people to lose trust in the system, and the perception of the second pillar has become generally speaking quite negative; even though by all objective criteria, such as outlined in the Ideal retirement Systems research, the Dutch pension system on the whole remains one of the best in the world, even today.

There is much ongoing discussion amongst employer and employee organizations and other stakeholders about possible reforms to the second pillar pension system. Two new key publications which set out the future expected course for the second pillar were published in July 2015, the “Act on Variable Pension Payment” and the “Guidelines for a Future-Proof Pension Scheme.” The former is a law which for the first time permits retirees from defined contribution


pension plans to stay (partly) invested in their retirement accounts, allowing them to maintain exposure to higher yielding asset classes, rather than being forced to purchase a life-long annuity at retirement. The latter is a discussion paper from the pensions minister, seeking commentary from the industry on the future of second pillar pension benefits in the Netherlands.

While many of the details still need to be agreed upon and the full practical implications of new legislation is not yet known, the suggested changes to be made to the system over the coming years are expected to be comprehensive. Two areas where there may be opportunities under the new second pillar pension regime are as follows:

1. “Removal” of (perceived) guaranteed benefits

Under the current approach for defined benefit pension plans, actuarial forecasts are used to determine what contributions need to be made and what benefits can ultimately be paid. If the assumptions used in these forecasts do not bear out in practice, in a negative scenario sponsoring companies of DB plans will generally either have to make additional one-time contributions to the pension funds to make up the shortfall in funding, or increase premiums, or both. Unfortunately, such cash-calls from the pension funds typically occur at the worst possible time for sponsoring companies and employees; a general economic downturn will often cause pension assets to decline at precisely the same time as many companies are suffering economically, thus making it more difficult to make additional contributions to their pension plans. The only tools available to the pension funds to deal with such situations at the time being are to increase required contributions, to cut pension indexation benefits, or to reduce the benefits in extreme cases. regrettably, under the current market conditions, more and more pension funds find that they are forced to go this route, and many employees who mistakenly thought that their benefits were guaranteed are shocked and dismayed to find them being reduced. To maintain faith in the pension system, it is important to create a framework where participants realize that the growth of pension assets is a major factor that will drive the level of their future pension benefits, and that if growth does not happen as expected, their benefits may need to be adjusted.

Mercer has come up with a unique and creative plan design, which we believe will work well under the new framework:• Allemployeesparticipateinapensionplanthathasamaterial amount of exposure to growth asset classes; this will ensure that the expected pensions at retirement are higher than they would be if a more conservative invest-ment strategy were to be used. Projections of future benefits should be provided to all employees, but it needs to be made clear to all participants in the communication that benefits are not guaranteed, in order to manage expecta-tions and to avoid surprises.• Beginningatacertainage(perhaps around 50 or 55), the asset performance could be smoothed over a period of perhaps 10 years. Thus if there is a year with poor asset performance, where for instance 10% of the pension assets are lost, this would only impact the benefit for someone one year before retirement by 1% instead of 10%. This would allow participants to maintain exposure to growth assets right up until retirement, which increases the expected return on pension assets considera-bly as compared with the use of a life-cycle investment model. The change in legislation which no longer forces people to purchase annuities at retirement also allows exposure to growth assets even beyond retirement, which further increases the expected asset returns to plan beneficiaries. If there is an extended period of negative returns, then these would need to be socialized amongst the group of “older employees” for which the smoothing applies, ultimately leading to a material reduction in benefits for this group. This being the case, even in the “worst-case” scenario, the reductions will not come as a surprise, and in the long run, we expect more people to be better off under this type of approach when compared with a more traditional investment approach.

2. Pensions contributions to be fixed at a prudent level

Pensions represent a long-term financial commitment. The contributions that would need to be made over the course of someone’s career in order to finance a given pension benefit are uncertain and are dependent on a large number of factors, one of the most critical being the return on the underlying assets. Historically, company contributi-

ons to DB pension schemes were quite volatile, as they were dependent in part on external factors

such as market bond yields, which themselves are inherently volatile.

While companies were traditionally quite happy to

pay lower contributions (or even take a

contribution holiday) in periods where

expectations were exceeded, many found that the requirement to pay more than expected when performance goals were not

met put them under immense

strain. In light of this, it may be

prudent for plan sponsors in the future to

choose a plan design which allows them to set a stable and

predictable contribution level which is expected to yield adequate benefits

over an individual’s career, such as 10% of salary, instead of having to base their funding requirements on highly volatile long-term financial projections, as is often currently the case. Doing so would ensure that employers would have a predictable and thus manageable pension expense each year and not result in an unfortu-nate asymmetric result. We currently see that companies are allowed to make smaller contributions when the markets are performing well, but are required to make larger contributions during periods of economic downturn.

While we expect that the changes in pension law will help to bring about a greater degree of stability to the Dutch pension system, the positive attributes of the current pension regime, such as cost effectiveness and mandatory participation, should be maintained.

additional areas for improvement

Although the Dutch pension system is one of the best in the world, there are still some areas for improvement. One area in particular is the level of labour force participation for older workers: Encouraging people to work longer would have the compounding effect of giving the individuals more years to accrue a pension, as well as less years of expected retirement during which they would need to live off of their pension savings. Extending an individual’s working life by a relatively short period can, through these compounding effects, have a large impact on the monthly pension amounts that the individual would ultimately receive once they retire. Increasing the state retirement age even modestly can also produce material cost relief for the country, for the same reasons.

conclusions

The Dutch pension system has consistently faired very well when compared with the pension systems in other countries. Nevertheless, the Dutch second pillar system is not immune to the problems facing pension systems in other geographies, such as an aging population and the low interest rate environment. By maintaining the positive characteristics of the system, such as broad-based coverage through mandatory participation, while making changes such as the removal of guarantees and volatile contribution schedules, the pension system will hopefully remain sufficiently robust to stand the test of time and provide an adequate retirement income for many generations to come.



Proactive planning as the answer to consumer and labor market uncertainty in the Netherlands

MANUEL GArCíA-HUITróN

Strategist

MICHIEL VAN LEUVENSTEI JN

Strategic Policy Advisor APG

ALWIN OErLEMANS

Chief Strategy Officer APG

A six pillar approach to financial planning during an individual’s

life-cycle can make a significant contribution to addressing

uncertainties. To be able to seize the opportunities in this domain,

existing institutions will have to roll up their sleeves.

pension stab i lity growth

six pi llars ( i nstead of th r ee)

I T H E G O V E r N M E N T ’ S B A S I C S T A T E P E N S I O N ( A O W ) , S U r V I V I N G D E P E N D A N T S A C T ( A N W ) A N D

T H E W O r k A N D I N C O M E ( C A P A C I T y F O r W O r k ) A C T ( W I A ) ; I I T H E E M P L O y E r ’ S G r O U P P E N S I O N ;

I I I I N D I V I D U A L P E N S I O N O r A N N U I T y ; I V S A V I N G , I N V E S T I N G A N D I N S U r I N G ;

V E q U I T y/ D E B T I N O W N H O M E ; V I L A B O r ( H U M A N C A P I T A L )

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the idea in brief

An integral vision and approach to planning finances and employment during an individual’s life-cycle can make a significant contribution to lowering uncertainties. Due to new technology, we are in a better position to form a clear picture in advance of the impact of potential events that affect income, health and employment and to develop a plan tailored to the individual. The new technology provides new forms of financial planning, a better estimate of someone’s (earning) capacity and additional opportunities to take out insurance in advance. This also makes it possible to develop better incentives designed to limit risks in advance.

To be able to seize the opportunities in this domain, existing institutions will have to roll up their sleeves. This will enable employers’ and workers’ organizations to proactively operate with a focus on increasing employability and preventing unemployment and occupational disability. This demands attention to the existing organization of instituti-ons and the application of new incentives, and a different role for government. Changing institutions takes a great deal of time and it is therefore good to take the first step, thinking about this, sooner rather than later.

uncertainty among households increasing

Households in the Netherlands are faced with increasing uncertainty. Government is shifting risks to its citizens and the facilities on which its citizens can rely are being scaled down. A permanent job is less certain in a rapidly changing

economy. This uncertainty is reflected in higher (long-term) unemployment compare to the beginning of the Great recession in 2008. The uncertainty among households is also increasing, because fewer permanent employment contracts are available. The number of temporary employ-ment contracts has increased considerably and the number of self-employed has risen significantly. Social security has been cut back in recent years and is therefore less effective in terms of its operation as a safety net. These develop-ments can be expected to become trends for the future as well.1

an integral life-cycle vision is required to better anticipate uncertainty

Consumers are generally forced to respond to uncertainty when they experience its negative effects, for example due to the loss of their job, occupational disability, divorce, or the sudden death of a family income-earner. It is important that the shift of responsibility from government to consu-mer is perceived on a timely basis by consumers. The increasing uncertainty among households creates a greater necessity for instruments to deal with this. However, consumers are as yet unaware of the need for such instruments. Behavioral scientists are considering how to better prepare consumers should they be faced with life-cycle events concerning finances, work and their own household. Better insight into their own situation and the perspective for action are required to assist the consumer. Integrated financial planning that includes all household income and equity components provides opportunities to develop a good overview of the income position and risks

over time.2 A six pillar approach is required to develop an integral view of income, finances and work over time. This is a broader approach than the prevailing three-pillar-based pension approach by expanding it to include the equity domain (held at financial institutions and in the home) and at work. The six logical pillars in this model are as follows: I. The government’s Basic State Pension (AOW), Surviving Dependants Act (ANW) and the Work and Income (Capacity for Work) Act (WIA); II. The employer’s Group Pension; III Individual Pension or annuity; IV Saving, Investing and Insuring; V. equity/debt in Own Home; VI. Labor (human capital). This is illustrated in Figure 1.

The pillars differ in terms of degree of liquidity over the life-cycle and in terms of composition, the degree to which it consists of equity or debt. Furthermore, income is a flow variable and equity is a stock variable. During the life-cycle, the income acquired through labor is converted into consumption or equity. For example, a purchased home is illiquid and at the beginning of the life-cycle primarily stocked with debt; 30 years later, the home primarily comprises equity, but still remains illiquid. At the beginning of the life-cycle, the pension is stocked with equity and at the end of the life-cycle, the equity is primarily invested in fixed-interest debt securities and can only be converted into

liquid assets from a certain age. The pillars saving, investing and insuring are largely liquid and primarily consist of the current account balance at the bank, equities and bonds.

essential to integrate the labor factor into the approach

Labor is the natural source of the other pillars. During working life, the Labor pillar transforms an illiquid form of capital (human capital) into a liquid form, salary or income, by means of an employ-ment contract or an assigned job for a self-em-ployed. When you are young, the value of this human capital is difficult to estimate. As you increase in age, a track record increasingly emerges that can be used as a basis for estimating the value of the human capital. Staffing agencies are well-equipped to determine the labor market value of candidates.

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Integral approach of the various pillars (liquid and illiquid)

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Figure 1: the six pillars

pension structu r e / age pension structu r e / age pension structu r e / age pension structu r e / age

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0START PeNSION

16-24growth pension

24-67START CONSuMe PeNSION

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consume pension per iod consume pension per iod consume pension per iod consume pension per iod

67-70 71-76 77-82 83-


Human capital is the most important source of income. Before retirement it needs to be protected from shocks during the labor career through life insurance. At retire-ment and until death what is needed is protection against the risk of outliving savings.3 The sixth pillar (Labor) currently is understood to include: mental value (study), vitality (health) and salary.

an integral vision requires individual planning across the entire life-cycle

The provision of individual advice to consumers has become more complex with the increase in individual responsibility. This advice comprises two key developments. First, the sector is undergoing professionalization and is subject to more stringent regulatory requirements (duty of care). Second, increased use is being made of technology and

digitization to substantively improve advisory services and make them more accessible (e.g. pension tracking portals and robo-advice). Much of the advisory services was focused on selling specific pension, saving, investing or mortgage products. As a response to these sales-driven advisory services, the regulatory duty to care criteria were (rightly) increased. Often, we observe that the advisory services do not have much of an integral character and – in part due to the sales-driven approach of the past – are highly fragmented, for example, with a sole focus on financing a home or providing a pension. To be able to better deal with uncertainty requires an integral approach that matches the key aspects concerning income and wealth creation; an approach that matches the six pillars in Figure 1.

Two trends are important to help move this a big step forward: 1) better insight into consumer behavior and technological opportunities to exploit this behavior; and 2) availability of data about the consumer’s various income and assets. In setting up an integrated life-cycle plan, it is possible to make use of the experience from new applicati-ons that provide information about people’s behavior so that the experience of one consumer becomes useful to another consumer (peer-to-peer). The advance of digitiza-tion makes access to data much easier. Pension informa-tion in the first, second and third pillars is often digitally accessible. Furthermore, banks and other institutions provide information about the current account and wealth creation. In addition, information about mortgages and housing values is also available. The Dutch Tax and Cus-toms Administration assembles most of this information. The consumer can view most of this data via DigiD. There are also developments in the labor market domain focused on evaluating the employability and earning potential of an employee or self-employed. There is enormous potential of providing the consumer with better insight into his situation if this information were to be pulled together. Technology furthermore makes it possible to make this facility cost-efficiently available. But a lot still needs to happen to reach this point. In a recent report,4 the Netherlands Authority for the Financial Markets (AFM) expressed the hope that suppliers and other stakeholders will join forces to come up with solutions. Furthermore, key issues in relation to duty of care, roles and responsibilities need to be resolved.

pension c hoic es

wh ic h on e is th e b est for me?

how muc h do i n eed?

pension c hoic es / solution

PENSION TAXI

pension taxi

with coac h h elps you to you r pension

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li n e of h ead l i n e of haert l i n e of h ealth

little l i n e of h ealth weddi ng li n e gi ddle of ven us

pension li n e of l i fe

line of life

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line of heart

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the example of the self-employed

The inclusion of the sixth pillar is also essential to under-stand and ultimately to better service for the specific needs of individuals or groups of individuals. Take for example the case of the self-employed. The self-employed is someone who has a lot of intangible assets. The value of its human capital is determined by its social network and workman-ship, which are difficult to estimate. The self-employed can know long periods of no income. Income smoothing with self-employed therefore work differently because they do not have a continuous flow of liquidity that they can move into the future.

For that reason, the self-employed can be seen as risk bearer, who shares risks within projects. Success for them is indeed not granted at any rate and even the successful among them rejoice telling stories about their many failures before success finally arrived. Most self-employed will need to re-invent themselves at least once in their careers, either to pursue another venture or to reinsert back into the employed world. The self-employed has, as it were, shares in himself and may decide to pay dividends to himself for his future self and the dividend then be managed by a pension fund. How much dividend it pays to himself that rules can be drawn on in terms of absolute amount for a certain income, but the self-employed has the discretion to deviate from the rules when needed.

The end result is that as a group the self-employed is one of the most vulnerable at retirement. A recent survey by APG, Harvard University and Erasmus University rotter-dam 5 shows that instability of income, lack of conviction of need to save and distrust in the financial markets and a perceived need to maintain control over savings are some of the main potential obstacles in saving through pension funds for the self-employed. These findings show that the type of uncertainties revolving around a self-employed career could be very different that those facing the em-ployed and should be therefore incorporated when desig-ning pensions policies and products for such a group.

all for one, and one for all

The sixth pillar feeds pillars one to five, through taxes,

contributions, savings and other life and financial decisions. Due to the increased uncertainty and reliance on individual decisions, it is more important than ever that the other pillars also reinforce the Labor pillar during the life-cycle. Various examples come to mind: 1. Study loans whereby the pension assets can be used as security reinforce a person’s human capital. For older individuals, such loans could finance a switch to a second career. The incentives are also better than they are for the current forms of government study loans. Individuals are less likely to choose study programs with little labor market perspective if they know that their pension serves as security. 2. On the investment side of pension funds, social impact bonds could make a contribution to work resumption or helping people move from work to work. By investing in work resumption projects in their own sector, workers’ job opportunities can be enhanced.6

3. Health impact bonds are bonds that affect people’svitality. For a health impact bond, a private party finances the intervention at the front end, whereby the performance of the intervention is agreed upon in advance. In case of a successful intervention, there is a gain in health and cost savings. The investor’s return is paid from the cost savings. Investments can limit occupational disability this way.7 Furthermore, supplementary products in the event of occupational disability can be focused on revitalizing people.4. For the self-employed, a carefully designed scheme of limited specific purpose withdrawals from pension savings may assist them in periods of liquidity duress over their life cycle.8 These schemes may compliment the role of the abovementioned social impact bonds, at times when the self-employed need to re-invent themselves.

Proactive approach instead of response afterwards

The creation of public and private facilities for social security, as well as pensions, were an after-the-fact response to a changing labor market and society. As such, facilities were a solution to issues that emerged as a result of innovations in the economy and society. At the end of the 19th century, our forefathers were also confronted with an industrial revolution that put the relationship between the factor Labor and the factor Capital under pressure.


Their solution was to organize solidarity circles that were responsible for the ex-post redistribution of income and where everybody paid the same price. Solutions were developed for people who became sick, unemployed or occupationally disabled. The first solutions were put forward by the trade unions and socially committed entrepreneurs. These solutions were later institutionalized by government.

The current industrial revolution is based on the technolo-gical development of the information and communication technology sectors. This technology ensures that we know more in advance as to who is exposed to what risks. This hampers the organization of solidarity circles. The traditio-nal way of organizing solidarity afterwards no longer works, because it is not considered fair in the event of ex ante transfers. Indeed, the veils of ignorance about many risks has been lifted: Why should I have to contribute to ano-ther’s risk when I know that my exposure to that risk is much less than that of the other? The technological developments of the fourth industrial revolution will increase the uncertainties for the Labor factor. It is not

entirely clear as to who will benefit from this industrial revolution. It is possible that many jobs at the lower end of the labor market will be automated; it is also possible that many jobs in the mid-segment will disappear (accountants, real estate agents, etc.).

The solution to this uncertainty is to stimulate risk sharing. For example by organizing markets in which everyone in advance partially insures himself against unemployment and occupational disability risks. Why do these markets not just come about by themselves? First of all, this is due to risk selection. Everyone who thinks they run a higher risk insures himself against that risk causing the insurance to become so expensive that it is no longer attractive. Second, there are market imperfections due to human behavior. People always think that someone else will be affected by illness or occupational disability. The obligation to take out insurance against the risk of unemployment (income) and occupational disability could make a contribution to this. There is a role for government here to facilitate this development. In other words, we should think about this in advance, instead of solving this afterwards.

1. See De Beer, P.,2016, De arbeidsmarkt in 2040 (The Labor Market in 2040): Ingrijpende veranderingen, maar ook veel continuïteit, AIAS-studie (Drastic changes, but much continuity as well, AIAS Study). Harchaoui, S., 2016, Health impact Bonds - An Introduction, Society Impact.2. Lapperre, P. and A.G. Oerlemans, 2015, Next generation pensioenplanning: zelfmanagement biedt kansen voor aanbieders (Next generation pension planning: self-management offers opportunities for providers), Het Verzekerings- Archief, Number 4, p. 221-227.3. See roger G. Ibbotson, Moshe A. Milevsky, Peng Chen, CFA, and kevin X. Zhu, 2007. ‘Lifetime Financial Advice: Human Capital, Asset Allocation, and Insurance.’ Research Foundation of CFA Institute Monograph.4. AFM, 2015, Neem drempels weg opdat Nederlanders in actie komen voor hun pensioen (remove thresholds to enable Dutch citizens to take action on their pension), October.5. ‘Save More Today: Improving Self-Employed Pension Savings In The Nether- lands’, 2016.6. Phlippen, S., 2016, Social impacts bonds zijn een breekijzer voor bureaucratie (Social impact bonds are a lever for bureaucracy) - See more at: http://www.economie.nl/weblog/social-impacts-bonds-zijn-een-breekijzer- voor-bureaucratie#sthash.FnWShyGd.dpuf.7. Harchaoui, S., 2016, Health impact Bonds - An Introduction, Society Impact.8. See Valdes, S, 2004. ‘Improving Mandatory Saving Programs.’ The World Bank; and García-Huitrón, Manuel, 2014. “The role of Annuities, Partial Lump-Sums And Special-Purpose Withdrawals In Pension Design. NETSPAR Masters Thesis.

who will take up the gauntlet?

The fact that the government is scaling down in the area of social security demands the development of institutions that give employees and employers better incentives to get and keep people in employment. This time, not institutions that make after-the-fact arrangements (at the time of unemployment), but institutions that respond proactively on the basis of changed expectations and that think ahead, in advance of the time of unemployment. The institutions in the domain of public and private social security benefits are faced with a tremendous challenge in terms of maintai-ning their relevance. An important aspect in this respect is that they must provide an infrastructure that supports consumers to better manage the risks coming their way. Providing integral life-cycle planning assistance is part of this, as is the provision of facilities that contribute to increasing employability on the labor market through education and further training, and the provision of collective (public or private) facilities in which consumers can share or mitigate risks. For pension funds, insurance companies and (other) suppliers of financial products, there are opportunities here in assisting consumers and offering quality and safe long-term investment opportunities. The integral approach to planning, including wealth creation, and promoting employability on the labor market throug-hout the entire life-cycle, makes this a challenging domain for employers’ and workers’ organizations, and the organi-zations that support them.

Pension providers are extremely well-positioned to support consumers with their long-term financial planning and wealth creation. In this respect, they can fulfill the role of trusted advisor and provide access to institutional wealth creation opportunities to consumers. Support of the consumer requires large investments in reliable platforms. Who will take up this gauntlet?

As responsible investors, pension providers fulfill an impor-tant role. In this respect, they can devote specific attention to the S in ESG (Environment, Social, Governance) policy, social investments. For example, they could invest in social impact bonds for initiatives designed to help people move from work to work. In addition, there are also health impact bonds that reinforce people’s vitality. In addition, as investor, they could be a driver to have the risks of fixed contracts

repackaged, so that these risks can be better distributed in advance, as a reinsurer of the risks of fixed contracts.

Furthermore, new unemployment and occupational disability insurance vehicles require employers’ and workers’ organizations and government to assume a different role. Government will have to act as facilitator through means of legislation so that the risks that the consumer is unable to carry himself continue to be insured and where neces-sary, the principle of mandatory participation is applied. Employers and employees will have to be prepared to bear the costs of these facilities, so that employees continue to be employable and employers can keep their workforce up to date in terms of knowledge and health. Social Invest-ment Funds 2.0 may be required that organize the unem-ployment benefit payments and the work-to-work initia-tives. For that matter, the implementation of these new facilities could very well be left to the market.


Chilean insights for the Dutch pension debate

The Dutch can learn a few lessons from the Chilean experience. The 2008 Reform, the recent debate in Chile and the Bravo Commission Report that evaluated the Chilean pension system draws relevant lessons for the current Dutch discussions on pension design.1

SOLANGE BErSTEIN

Principal Expert Pensions, Inter-American Development Bank


pension c hoic es

c h i li : select c hoic e

b ravo even less c hoic e: not five but th r ee

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retirement phase it was also considered relevant to find a way to find a way to increase longevity risk sharing, the Bravo Commission proposed in this respect compulsory annuitization.

Another topic of potential interest for the Dutch debates is the status of the self-employed. The 2008 reform introduced automatic enrollment for a limited period of time --initially three years but recently extended--for self-employed workers in a certain tax category. This temporary automatic enrollment program was supposed to become mandatory in 2015 but it was postponed. During the soft-compulsion period it was expected that a large number of self-employed workers would start contributing. There was a significant increase from 5% to almost 30% of the target population; however, it was considered to complicate to force 100% of these workers in one year the total amount of the contribution. The reasons behind the lower than expected coverage, can be related to some design problems, but basically to an insufficient communication about the benefits of contributing.

insights for the netherlands

Freedom of Choice

From the Chilean experience several lessons can be learned. The most valuable one is that freedom of choice comes with restrictions. There is a clear trade-off between the freedom acquired and the restrictions im-posed. The positive element of freedom of choice is the sense of ownership that comes with it. People are owner of pension wealth and realize they have to think about retirement up until a point. We can not say that people become more knowledgeable about how to provide an adequate pension benefit. However, they are easily mislead by intermediaries when it comes to making sensible choices. They are easily tempted by a new bicycle, radio or other electronic device, and are subject to considerations that are not necessarily aligned with an adequate pension. This happened in Chile in the 1990s. The lesson is that the costs, service or risk/return profile of pension investments does not seem to be the most important drivers of decisions

by participants in a pension fund. Indeed, most of the switching was incentivized by sale agents (intermediaries) that had an interest in switching behavior by pension participants.

Chile has a lot of experience with choice between multiple funds and different pension providers. And this experience is not in all aspects favorable. On the one hand participants seemed to be more involved in pensions in general, but on the other hand the participants did not seem to be better informed when it comes to decision making in pensions. Short term considerations seem to be more important than costs and return of the pension portfolio. We have seen that behavior also during the financial crisis in 2008 and even after that in terms of investment decisions. A number of people changed from the riskiest fund to the less volatile in worst moment of the crisis, which implied making the loss and afterwards moving back to the riskiest fund. There are movements that try to maximize the short term return, but at a high risk.

Impose regulation

The role of intermediaries should not be underestimated. Therefore, the role of sales agents and advisors should be regulated. In Chile, they have to be registered; we have a lot of documentation required and penalties for misbehavior. For example, in terms of switching between providers, participants use to be able to switch twice a year because of the operational system took 4 months to change the registration by provider. So providers knew that participants once they had switched they would stay at least for four months. The value of this switch was so high that this implied that the providers could pay huge fees to sales agents and other intermediaries for every switching participant. Now, regulation in place makes sure that the operation takes less than 20 working days. Although this regulation made switching easier and faster, the number of switches remained limited.

Furthermore, the introduction of a bidding process for new members for a period of two years has lowered the cost of the pension providers. The 2008 reform introduced an auction mechanism by which all individuals opening an account in the pension system for the first time are not allowed to choose their provider but are tendered for the

lowest fee. The winner of the auction is entitled to the flow of all the new individual accounts opened as of some pre-specified date and for two years. After two years, the individuals can move to another AFP should they wish to do so. The growth of market share of pension providers is also mostly due to the acquisition of new members and not due to participants transferring their funds to another pension provider.

Competition and Information

One of the key points to understand from the Chilean system is the notion that control of information provision is important, because competition in itself does not mean that participants will make the right decisions for them-selves. The information asymmetry between intermediary and pension participant is large, but can be limited by standardizing the products and by creating a benchmark by an independent authority.

In the accrual phase, Chilean Pension funds (AFPs, by their Spanish acronym) manage a family of five funds that differ with respect to quantitative investment limits defined by asset class. Workers may freely choose up to two funds in which they wish to place their pension savings and they can switch to riskier funds, with the exception of participants close to retirement, who cannot select the most aggressive fund (Fund A). These options are available within the same AFP. Workers that do not make an active decision are assigned to a default fund that follows a lifecycle structure geared at de-risking savings using step-wise deterministic rules towards the retirement age. The Bravo Commission proposes the simplification of the multi-fund system by reducing the number of investment fund types from five to three-to make the scheme simpler for participants, by eliminating the riskiest and the less risky extremes.

In the decumulation phase, the Chilean pension system offers four well-structured products and a limited lump-sum option design. The decumulation products menu comprise phased withdrawals (PW), immediate life annui-ties (ILA), and hybrids based on these two products that include a combination with a deferred annuity (DA). A phased-out withdrawal is computed as a life time income and recalculated every year so that it remains a life time

From its inception in 1981 and up to 2008 the Chilean pension system consisted, fundamentally, of a large second pillar. A landmark reform in 2008 introduced a solidarity pillar, tackling the needs of the most vulnerable. The discussion after that reform has turned more to the adequacy of the pension benefits of middle income workers. The solidarity pillar is very much valued by the population in general and the Bravo commission acknowledges that, because it provides of protection for the lower income population and it is a risk sharing element which was absent before the reform in 2008.

The adequacy of benefits is low mostly because the participants contribute too little to their individual accounts, even in the case of middle income workers. Therefore, a number of measures were put in place to incentivize the contribution level such as subsidies for younger workers and new voluntary savings facilities. However, the subsidy program which was in place for the younger generation turned out not to be very effective and voluntary savings have increased but still not substantially.

The Bravo Commission proposes to further increase the adequacy level of pensions by extending the retirement age above 60 years for women. Women on average only contribute for 15 years to the pension system, but are paid out for almost 30 years. This is of course an unsustainable situation. The Bravo Commission proposes to increase the contribution rate and to extend the solidarity pillar to the middle incomes to raise the level of adequacy. The increase in contribution would be allocated in part to finance this extension in solidarity, according to the Commission. In this way the contribution will be raised as well and the solidarity pillar will be less dependent on the national budget.

risk sharing is another important topic that was tackled by the Commission. The solidarity pillar is a risk sharing device especially for the most vulnerable. Through the fiscal budget of the government, the solidarity pillar compensates for fluctuations in the financial markets, but also for negative life events that would have an impact on the contributions of workers. Therefore, by extending the coverage of this pillar to a larger part of the population they would also benefit of this feature. Additionally, in the


income conditional on age that you have at every moment in time. So the pension decreases over time because as you age your life expectancy increases. So when I am 65 my life expectancy (of my cohort) would be 83, but once I get 70 my life expectancy of my cohort goes to 86. So when my fund is computed every year my money is stretched out over a longer time period in order to be able to pay an adequate pension benefit.

People are comparing an annuity that is constant over time and the phased out withdrawals that is a decreased line over time that is in the first years higher than the annuity pay-out but than is decreasing rapidly over time. When the interest rate changes in such a way that the phased withdrawal is very high compared to the annuity, people tend to choose the phased withdrawals. So the choice is very dependent on the pension outcome for the first year of payment, which depends on the level of interest rate. Therefore, the Bravo commission decided to propose to have only one option: compulsory annuiti-zation. The reason is that people tend to biased to phased withdrawals payments at once at the beginning of the period when due to the interest rate the first payment is higher. Of course, life time income is conditional on age. The older you are becoming the higher the life expectancy of remaining cohort, but this is not sufficiently taken in to account when participants are deciding between PW and an annuity. And then there is the issue whether you could expect that people are time consistent with themselves. When ex-post the outcome does not match the expected result, people tend to complain anyway, even though you may have given them the right information 20 years ago. However, the drawback of compulsory annuitization is that people with low life expectancy do no longer have the option to give their pension benefits as an inheritance to their family. And people may have the feeling that they have less ownership over the fund. The upside of com-pulsory annuitization is that there is more risk sharing which increases the pension benefits overall.

Like the Bravo Commission, I am in favor of more annuiti-zation, because this would enhance risk sharing of longevity risk, which will increase the average pension benefit. That a choice for annuitization meant lower inheritance of the next generation, is in my view of less importance, but still might need attention. My own proposal was to have

compulsory partial annuitizationto cover longevity risk at advanced ages, for instance starting at 80-85 years.2 This would be implemented by a longevity insurance premium that would be paid throughout the active working life and would cover pensions as from a given advanced age (Berstein et al, 2015). This would provide a floor to the ones that choose a phased withdrawal, and benefit largely from risk sharing. Products of this type have been widely studied in the literature. The payment of advanced-age benefits may be by means of a life annuity, provided by an insurance company or by the State; alternatively it could also be a mutual arrangement that spreads the risk across a generation.3

Financial planning

Finally, Chile has some experiences with reversed mort-gages. As Joseph ramos showed in his study, there are significant benefits of this type of products, but there are also costs that tend to be very high.4 Culturally, Chileans value bequests of the family home within the family. Very few Chileans see the advantages of living out of the value of their home. So, reversed mortgages are not popular in Chile. Actually, many Chilean families have arrangements within the family where children finance parents and help with maintaining the value of the home.

Another innovation is a hybrid form of DC which is advocated by robert Merton and is called targeted retire-ment products which are life time products. This a multi-funds product with a default option and life cycle that targets a replacement rate for the average worker. So these products are focused on the long term horizon. Participants have some freedom of choice. The default option is there to prevent a choice for a high risky fund with high returns. Although I see advantages to the use of targeted replace-ment rates that are individual based, a lot of regulation should be in place with regard to the communication of the product. For consumers it should be clear that it is a projection not a guarantee. Furthermore, because the results are only visible in the long term, the regulator should deal with the possibility of complaints by partici-pants for which the outcome did not match their expecta-tion. Having said al this, defined contribution pension schemes should indeed be long term oriented.

to conclude

Chileans have long experiences with competition in pensions. And the experiences are not in all aspects favorable. People may make choices but not for the right reasons. Intermediaries may use their advanced knowledge not in the best interest of their customers. Customers are easily subtracted by short term considerations. For all these reasons it is important to regulate a competitive pension market properly, by introducing standard products, and providing independent information on pension products. Furthermore, participants should be protected for their own wrong choices by limiting risky investment options and defining a proper default option.

Finally, the Bravo Commission that evaluated the Chilean pension system has come to the conclusion that adequacy of Chilean pension benefits is a major concern and that adequacy should be raised, not only by increasing contribu-tion and retirement age, but also with solidarity and risk sharing of longevity risk. In that sense, Chile seems also to have learned something from the Netherlands.

1. The report can be accessed (in Spanish) here: http://www.comision-pensiones.cl/ 2. Berstein, Solange, and Marco Morales, and Alejandro Puente. (2015). ‘rol de un Seguro de Longevidad en América Latina: Casos de Chile, Colombia, México y Perú.’ International Federation of Pension Funds (The role of Longevity Insurance in Latin America: The case of Chile, Colombia, Mexico and Peru).3. Milevsky, Moshe. (2004). ‘real Longevity Insurance with a deductible: introduction to Advanced-Life Delayed Annuities.’ Managing retirement Assets Symposium. Milevsky, Moshe. (2014). ‘Market Development of Deferred Annuities.’ Longevity 10 Conference, Universidad Diego Portales, Santiago de Chile. Milevsky, Moshe. (2015). ‘king William’s Tontine Why the retirement Annuity of the Future Should resemble its Past.’ Cambridge University Press.4. ramos, Joseph. (2015). ‘reverse Mortgage as a Fourth complementary pillar of the pension system.’ International Federation of Pension Funds.

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CHrIS CUrry

Di rector of the Pens ions Pol icy Inst i tute (PPI )

View from the Uk

Pensions have been reformed extensively in the UK in recent years, and the Dutch system is often used as example of what the UK should be aiming for. But is there anything that the Dutch pension system could learn from the UK reforms?

24

The Uk pension system seems to be in a state of constant change. Since the final report of the Pensions Commission in 2005 1 that highlighted many of the shortcomings in Uk pensions there have been a series of reforms that have affected every aspect of both pension saving and state pensions. On the state side, a new State Pension has been introduced for those reaching State Pension Age from April 2016, with the intention of eventually paying nearly all retirees the same flat rate state pension (although as with most Uk pension reform there is a long transitional period before the desired outcomes happen in practice). State Pension Ages are steadily increasing, and an independent review which concludes in 2017 is likely to recommend further rises in future.

In private pensions, the changes have been even more dramatic. Since 2012, employers have begun to automati-cally enrol all qualifying workers 2 into a workplace pension scheme, significantly increasing the number of people contributing to a workplace pension – an additional 6 million by March 2016,3 expected to eventually increase to 9 million.4

In March 2014, another major reform was announced. From April 2015, individuals with Defined Contribution schemes have much more freedom and choice as to how they use their pension funds. Whereas historically individu-als have had to use at least 75% of such funds to purchase an annuity (a guaranteed income for life), they now have complete flexibility as to how they take their funds (once they have reached the minimum withdrawal age of 55) and what they then do with it.

And further changes are expected. The Government recently consulted on changes to the way in which pension savings are taxed (contributions are currently exempt from income tax, investment is broadly tax free but most pension withdrawals are taxed). Although no changes have been made yet, the introduction of lifetime savings products (with penalties for withdrawals other than for a first house purchase before age 60) with a different but just as gene-rous tax treatment (contributions are made from taxed income but with a 25% bonus given, then investment returns and withdrawals are tax free) suggests that some proposals are still under consideration.

With all of these major changes occurring almost simulta-neously, you might think that the Uk has now sorted out its pension system, and is looking forward to a period of relative stability. But far from it. And this is where I think international observers – including the Netherlands – can learn some useful lessons.

The first important lesson is that pension reform takes time. The Pensions Commission first recommended automatic enrolment into workplace pensions in 2005. The process began in 2012. Because of the way it is being introduced to the largest employers before the smallest, and contributi-ons being introduced at a low level before increasing to the agreed minimum level, it won’t be until April 2019 that the policy is finally fully in place – almost a decade and a half later. So if the Netherlands is facing similar problems to those identified in the Uk related to higher life expectancy and lower expected investment returns leading to higher costs, starting to deal with the issues sooner rather than later could make any reform less severe than it might otherwise need to be.

The next lesson from the Uk is that reforms can be easier to implement where there is a degree of consensus around what needs to be done. A good example of this is automatic enrolment, which had a very high degree of consensus not only across political boundaries, but also with employers and representatives of employees (such as charities and trades unions). This has meant that there is still widespread support for the principle of automatic enrolment despite the lengthy introduction period and the changes in the economic climate that have happened since the idea was first proposed.

There is, at the moment, less consensus around some of the other changes in private pensions, such as freedom and choice in DC pensions, which were introduced much more

quickly and without prior consultation. Consequently, there is still a lot of uncertainty as to how people will respond to the changes, and what the implications might be for long term levels of pensioner income, and potentially Government expenditure. In the short term the Govern-ment might benefit by collecting more income tax as individuals withdraw money from their pensions more quickly than before, but in the longer term if people run out of money they may fall further back onto state support. Consensus doesn’t, however, guarantee that things will always work smoothly. Even though there is widespread support for automatic enrolment, the original idea has led to much wider reform than originally envisaged. Part of this can be ascribed to another lesson – know what you are ultimately trying to achieve. The concept of auto-enrolling workers into schemes has been accepted, but it soon became clear that it might not make sense to enrol people into schemes that were not good quality – with good quality meaning well administered, well governed and without excessive charges. So it is important to look beyond the tools you are planning to use to see what the outcomes

are that you would view as successful. In the Uk, there have been numerous attempts to improve regulation, increase standards and lower costs – in fact even to discover what the costs are – that are still going on even though people are now being placed into schemes. While it was originally thought there might be a handful of large multi-employer mastertrust schemes entering the market to provide schemes for smaller employers, over 100 have entered and there are concerns that not all of these will be viable in the long-term, or provide good outcomes for members.5 But this is where the Netherlands already has a comparative advantage. The very characteristics that the Uk are trying to build into the pension system, such as economies of scale, and efficiencies and transparency of investment costs, are strengths of the Dutch system. So the next lesson is build on what you have that already works well.

Scale and transparency are just 2 of the areas in which the Uk has looked to the Netherlands for examples of best practice. A number of Uk reports have suggested that the way in which the investment industry operates in the Netherlands has significant advantages over the Uk,6 not least in terms of the efficiency and low cost arising from investing with scale. And while the Uk has placed a charge cap on costs for the funds used as default investments for automatic enrolment, the Government is still struggling to even identify the levels of costs involved with running and investing pension scheme assets. The Netherlands appears to be leading the way in transparency too.

The other area where the Uk has been looking to the Netherlands – although not as yet following their example

Pension reform takes time

Reforms can be easier to implement where there is a degree of consensus

Know what you are ultimately trying to archieve

Build on what you have that already works well


– is in the allocation of risk between pension sponsors and scheme members. In the Uk there has been a straightfor-ward move away from Defined Benefit schemes – with the majority of risks being taken by the scheme sponsor – to Defined Contribution schemes with the risks being faced by the scheme member. This has led to some concern that the scheme members who do not understand, for example, investment, inflation and longevity risk, will be unable to adequately manage their income and assets throughout their retirement (perhaps not universal concern however, as the introduction of more freedom and choice at retire-ment has increased the exposure to these risks).

The Uk Government was so concerned that it began to introduce legislation to allow for different types of “risk sharing” pension schemes to be developed, which could allocate risks either between the scheme sponsor and the member, or between different groups of members, in ways between the extremes of Defined Benefit and Defined Contribution. recent developments in the Netherlands – such as the use of conditional indexation - were used as examples of how this might work in practice.

The Uk Government commissioned the PPI 7 to look at how some of these schemes, and in particular Collective Defined Contribution (CDC) schemes, might improve member outcomes compared to the traditional Defined Contribution (DC) approaches used in the Uk – individual accounts, life styled and then used to purchase a lifetime annuity from a provider. There were some interesting findings.

In the long term, once the scheme is mature and the scheme population is stable, the CDC schemes modelled (with a 10% contribution rate) produced better outcomes than the traditional DC scheme based on the same contribution and used to purchase an annuity – providing a replacement rate (of pension compared to earnings) of between 27% and 30% in CDC compared to between 12% and 21% in DC. However, these results were heavily driven by the assumption of scale, and assuming that there was an element of pre-funding in the CDC schemes (so they start off well-funded). And the traditional DC results were lowered by the requirement to purchase an annuity in the market place (with associated costs for risk management and assumed lower investment returns compared to a

CDC scheme where the annuity is paid from the scheme that can remain invested on a collective basis).

But even without these advantages, the CDC scheme performed as well as the best perform DC alternative, was less likely to run out of money, and had a more certain, narrower range of outcomes.

Although this research was narrowly defined, and set very much in Uk context, it does highlight one of the current strengths of the Dutch pension system, the ability to share risks. This is not painless, and does not always work well if it is not well defined or well understood, but from an indivi-dual perspective might be preferable to the uncertainty offered by pure DC arrangements.

But even with these findings, the legislation needed to put these schemes into practise has stopped, with no sign of starting again. Why? A lack of demand from scheme sponsors, who at the moment seem broadly happy to offer DC schemes with no (obvious) risk to themselves (there may well be reputational risk, and difficulties in managing an increasingly elderly workforce if the pensions perform badly). And no real demand from providers to be able to set up the schemes either – linked of course to the lack of demand. Once the system has moved to DC, it is hard to move it back.

you may have noticed that in the PPI research looking at CDC schemes, the contribution rate was set at 10%, and the resulting replacement rates were still pretty low. That

Once the system has moved to DC, it is hard to move it back

is not at all unusual for DC in the Uk, and is in fact above the minimum default contribution required (which will undoubtedly become the most common).8 This is another area in which the Dutch system starts from a position of strength. Not only are contributions considerably higher in the Netherlands, there is (or so it appears to the Uk) little concern that these contributions are not affordable. Whereas in the Uk we have had to introduce a system based on inertia so that many people will not even realise they are saving into a pension scheme, the Netherlands population appears to have a savings culture based around agreement from the Government, employers and employ-ees. Perhaps the greatest challenge facing the Uk system is how to increase contribution levels. The Netherlands does not have the same problem – and this is a real advantage.

So, what can the Dutch learn from a view from the Uk? Firstly, hang on to the strengths in the system – scale, transparency, efficiency, and buy-in from the members. Secondly, if risks need to be reallocated (typically towards members), make sure those bearing the risks are aware of them, can manage them, or have them managed on their behalf (for example through defaults). If you are starting on a journey of reforms, know where it is you want to go – in terms of what the system should deliver – from the outset. Get as much consensus as is possible along the way – if everyone is on the journey together, and you all know where you are going, there is more chance you will arrive. And finally, be aware that once you have started, it can be very difficult to go back to where you started. Once sponsors have shed risk, they can be loathe to take it back.

Chris Curry is the Director of the Pensions Policy Institute, an independent research institute with no political affilia-tion specialising in research into Uk retirement issues. 1. The Pensions Commission (2005) A New Pension Settlement for the Twenty-

First Century: The Second report of the Pensions Commission2. Generally employees aged between 22 and state pension age, earning more than £10,000 per year3. The Pensions regulator (2016) Automatic enrolment Declaration of compliance report July 2012 – end March 20164. DWP (2015) Millions more saving due to automatic enrolment, Government Press release5. Pensions Policy Institute (2015) Comparison of the regulatory frameworks for DC pensions6. See for example Pitt-Watson, D. (2013) Collective Pensions in the Uk II: Now is the time to act 7. Pensions Policy Institute (2015) Modelling Collective Defined Contribution Schemes8. Currently automatically enrolled individuals must contribute a minimum of 2% of earnings between £5,824 and £43,000, of which at least 1% must be an employer contribution. By April 2019 this will rise to 8% of earnings in this band, of which at least 3% must come from the employer.

Perhaps the greatest challenge facing the UK system is how to increase contri-bution levels


JOHAN BArNArD

Head of International Public Affairs, APG

WILFrIED MULDEr

Strategic Policy Advisor, APG

European Pension Plans

The initiative from the European Commission for the

development of a Pan-European Personal Pension Plan (PEPP)

aims at to many goals to be realized at the same time, using

only one policy instrument. The focus should be on filling existing

pension gaps, starting with the most important ones. More

attention is needed for incentives and distribution, which may

call for somewhat different approaches in different member

states. Therefore the implementation of a phased and

multifaceted approach should be considered.


pension savings

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introduction

In its action plan1 on building a Capital Markets Union, the European Commission announced that it “will assess the case for a policy framework to establish a successful European market for simple, efficient and competitive personal pensions, and determine whether EU legislation is required to underpin this market.” In a “first status report” on the CMU2 the Commission also announces a public consultation of its own, after having received requested advice from EIOPA in May 2016. key idea of the Commis-sion is to encourage more pension savings in order to increase pension adequacy in specific member states and/or for specific vulnerable groups,3 and to channel these savings towards long term investing to help establish a Capital Markets Union. Although no decisions have been taken, both EIOPA (taking into account its recent consulta-tion of a personal pension product)4 and the Commission seem to consider a “2nd regime” for a third pillar pension product. An analogy often mentioned is UCITS.

Important to note as well, is that part of the justification for an eventual proposal may also be a need to enhance the internal market, both for pension providers as well as for beneficiaries and members. In some markets in some member states competition may be limited, and certainly European solutions would help achieve economies of scale. Workers making use of their Treaty rights by pursuing an international career are now faced with at least considera-ble complexity in catering for good pensions because of the existing differences in member state pension regimes.

tinbergen rule

Dutch economics Nobel Prize winner Jan Tinbergen (1968) formulated a rule that in any systemic and coherent model of the economy, one needs at least an equal number of policy instruments to reach a given set of policy aims. Although politics, and also politics of European integration, often follow their own logics, this Tinbergen rule should make us pause to consider what the real aims for a Personal Pensions Plan could be. Mentioned are:1. Enhance pension savings in the EU2. Fill pension gaps in Member States without adequate pillar 1 and/or 2 systems

3. Encourage more long term investments4. Encourage pension providers to provide services and/or establish across borders 5. Solve problems for workers with an international career in several Member States

All these policy aims are important, but to achieve them one may consider some prioritization and also adding further policy instruments.

Pension narrative?

The Commission announced its initiative to work on personal pensions in the context of the Action plan on building a Capital Markets Union, and therefore mainly as a source of savings that could be turned into needed long term investments. The risk of this framing is that one loses sight of the underlying ageing and pension adequacy problem, as is described in the Commission’s 2012 White paper on Pensions 5 and in the 2015 Pension Adequacy report. At the same time this context can also be read as an indication of ambition. Substantial extra long term investments need substantial extra savings. Therefore priority should be given to the largest pension adequacy problems. These do not relate to the relatively low percen-tage of international workers within the EU, but instead to large groups in the working population of several member states that either have no access to satisfactory pension products, or, for whatever reason, do not make use of these products. Starting from these groups and an analysis of their problems, appropriate (set of ) policy instruments should be found. A third pillar European Personal Pension Plan can be one of those instruments, but the analysis should be broadened. In this respect a first step should be to further investigate the reasons of these inadequacies at national levels and to explain the differences between member states.

Distribution

At the present, still preliminary, phase of discussion, one gets the impression that a well defined European Personal Pension Plan, that can be provided by institutions of different kinds throughout the internal market, and that

should be portable for those who take it, will sell itself to large numbers of workers. And this will certainly be the case if a solution is found to ensure that existing tax incentives at the national level, will apply to European Personal Pension Plans as well.

Unfortunately this may be too optimistic. By far the majority of workers in the EU do not work across borders, and in quite a few member states decent third pillar pensions are already on offer, so it is not immediately clear what the introduction of European Pension Plans would change. Apart from the availability of adequate pension products, a big issue is that consumers in general consider pensions to be complicated and not very attractive subjects to look into, which easily leads to postponing or not taking any decision on how to provide for one’s old age. Tradition-ally this has been one of the reasons for the introduction of compulsory second pillar pension schemes in several member states (often by social partners). More recently behavioral economics have increased our knowledge and has led to initiatives to build better pension schemes by making use of ‘nudging’. One of the most interesting, and at first sight successful, developments in this area being auto enrollment in the Uk.

Cultural elements may play a role as well. The Netherlands for instance has both a well developed 2nd pillar and a decent market for 3d pillar products.6 Nevertheless also in the Netherlands one can find pension adequacy difficulties, in particular relating to the growing number of self-employ-ed without personnel. This group provides the Dutch labour market and economy with a lot of flexibility, but many do not sufficiently save for their pension. Several providers amongst which APG insurance subsidiary Loyalis, have created specific and very flexible products for this group, but demand has remained lower than expected.7 Within a wider political debate on the future of Dutch pensions, one of the issues is pensions for the self-employed and the question whether an obligation, or a compulsory auto-enrollment system should be introduced. In parallel APG has set up a research project with the Erasmus and Harvard universities to study possible “nudges”, that could lead to a better absorption(?) .

In order to effectively increase pension savings more attention is therefore needed to issues of distribution.

In terms of instruments attention also has to be given to 2nd pillar pension plans. The fact that at the European level no legal base may exist to legislate, should not lead to the immediate exclusion of this type of instrument, but rather to opening a dialogue with member states, for instance in the context of the European Semester, in which peer review between member states could lead to better economic policies at the national level. In addition the possible introduction of a High Level Group of experts to enhance occupational retirement provision in the member states, as mentioned in the recitals of the current proposal for a revision of the IOrP-Directive (IOrP II) 8 could be considered. And of course this IOrP II could, thanks to the proposed reinforcements in the field of governance, risk management and the provision of information can play an important role in the further development of 2nd pillar pension plans.

Gresham’s law?

In economics, Gresham’s law is a monetary principle stating that “bad money drives out good”.9 In the pension’s world some may hesitate about the introduction of a Pan-European Personal Pension Plan (PEPP), from the perspective that perhaps also “less sophisticated pensions, drive out better developed pensions”. One of the main ideas behind a PEPP is to fill existing gaps where people do not have adequate pensions. The introduction of a PEPP should not inadvertently harmonize downwards well functioning existing pension schemes in member states with less pension adequacy problems (for example as a result of PEPP’s replacing existing pension schemes), nor should it lead to a ‘one-size-fits-all approach’ in submitting different types of institutions to equal rules without taking due account of the differences between these institutions. It may be worthwhile to think a bit longer about this. More Europe, but less pension is not a good outcome.

tax and other difficulties

As with other financial services, tax is very important. Many member states operate tax incentives to encourage pensions saving. Unfortunately they operate different systems, and tax harmonization requires unanimity under


Pension Plans. Wishing these problems away, or just arguing about the internal market, implicitly mounts up to asking the member states to give up taxing rights and therefore future government income. Solutions to these problems will however take time and may have conse-quences for the design of such a product.11

Similar difficulties may arise around issues like duty of care, labour law and contract law.

how to continue: a phased and multifaceted approach?

Taking into consideration the aforementioned Tinbergen-rule, it is perhaps possible to think of a phased approach in which not all problems will have to be solved with just one policy instrument, in one go.

The first work stream of such phased approach should be encouragement of more pensions’ savings throughout the EU. The laudable initiative of Commissioner Lord Hill and his services could in this respect be reinforced by closely associating Employment Commissioner Marianne Thyssen and her services with this project. Perhaps it is possible to draft a core for a European Pension Plan in such a way that distribution is possible both as a personal as well as a collective Plan and therefore both in a 2nd and a 3d pillar context. The Commission should engage with member states to encourage them to do what is necessary at the national level to increase an uptake of more pensions by workers, be it national pensions or a new European pension scheme. In this context attention should also be paid to the question which institutions should provide pensions, and/or should be involved. Is this something one can leave to the market? Or could for instance social partners play a role as well?

The second work stream, which may take longer but could start at the same time, could look for a tax solution that is acceptable for all member states, also in a cross border context, and could be legislated in a tax directive. Advan-tage of starting in time with this would be that first results could then already l be taken account of in the design of a European Pension Plan, even before full unanimity is reached.12

In parallel other difficulties like duty of care, labour law and contract law will have to be identified and preferably solved. In order to alleviate difficulties of cross border workers, a first step could be a vigilant control by the Commission that existing Treaty rights, in particular non-discrimination, are scrupulously respected by the Member States. Furthermore the TTyPE-project (“Track and Trace your Pensions in Europe”),13 that seeks to establish a European tracking and tracing system that should allow all European cross border workers easy access to their pension situation in all relevant member states in an integrated way, could contribute considerably to the pension situation of cross border workers.

A third workstream could be to look at fundamental solutions for cross border pensions. These however may have wait until the moment the Member states are at least ready to agree to tax incentives that work across borders as well, if one does not want to run the risk of getting a very European outcome at the price of much less attractive pensions. (No incentives for anybody would go a long way to solve portability, but would not really help convince savers to buy these products …)

the Treaty. It is obvious that European Pension Plans in order to be successful should be at least as tax efficient as existing national pension regimes. In other words: a discriminatory tax treatment of a European Pension Plan vis-à-vis similar national pension products should be avoided. Early engagement with tax policy makers at the national level will be crucial. Success will also depend on taking into account legitimate tax considerations. For example many member states operate a tax system where premiums and capital gains in the accumulation phase are tax exempt, but pension income in the decumulation

phase is taxed.10 In judging the design of a European Personal Pension Plan, tax policy makers may consider it instrumental that effective taxation in the decumulation phase takes place, irrespective of the question in which member state a pension is drawn. And certainly tax policy makers will worry about possibilities for tax arbitrage, for example in the form of tax deductibility of paid premiums in one member states and a tax exemption of the resulting pension benefits. These are legitimate concerns of national tax authorities that will have to be addressed, in particular if one aims for between member states portable European

1. Action Plan on Building a Capital Markets Union, COM(2015) 468 final, 30.09.2015 2. Brussels 25-4-2016, SWD (2016) 147 final. 3. Compare: The 2015 Pension Adequacy report: current and future income adequacy in old age in the EU, joint report by the Social Protection Committee (SPC) and the European Commission (DG EMPL) 4. Consultation Paper on EIOPA’s advice on the development of an EU Single Market for personal pension products (PPP), 1 February 2016 5. White Paper, An Agenda for Adequate, Safe and Sustainable pensions, European Commission, Brussels, 16 February 2012 6. In its recent ‘Consultation paper on EIOPA’s advice on the development of an EU Single Market for personal pension products’, EIOPA-CP-16/001, 1 February 2016, EIOPA acknowledges this and mentions a particularly stark concentration of asset values in NL, Uk and Be (page 9). 7. Figures are mentioned in a recent newspaper article: http://www.nrc.nl/ nieuws/2016/04/27/zzper-en-pensioen-lastige-combinatie-1612548 8. Proposal for a Directive of the European Parliament and of the Council on the activities and supervision of institutions for occupational retirement provision (recast), recital 9a 9. https://en.m.wikipedia.org/wiki/Gresham%27s_law has a nice explanation. 10. EET = exempt, exempt, taxed 11. Excluding the decumulation phase and maximizing flexibility for the consumer, almost automatically complicates finding tax solutions, while for instance a compulsory annuity for pension draw down would be easier to handle, under any EET scheme. 12. End result could be two legal instruments, one directive decided by the ordinary legislative procedure and therefore with qualitative majority voting in the Council and codecision with the European Parliament, and a parallel tax directive decided by unanimity in the Council. 13. See www.TTyPE.eu

filled existing pension gap



Insights from the outsideAn outside view on the Dutch pension system

‘Beware that you can’t put the toothpaste back in the tube. Once freedom

of choice is in place, you can’t take it back if it doesn’t work out’, is one of

the main warnings of the experts from the Uk, Chili and Germany expressed

in the APG dialogue meeting on the reforms of the Dutch pension system.

SANDrA PHLIPPEN

Independent economist and sociologist PrOGrAMME / SPEAkErS

Chris Curry

Norman Dreger

Alwin Oerlemans

Johan Barnard

Solange Berstein

36

This warning addresses the fundamen-tal shift in our pension system where risks and responsibilities are being reallocated from funds to participants. The Dutch pension debate is for quite some time now centered around the question of whether increased indivi-dual choice is a necessary response to increased individual risks and responsi-bilities. “It provides those who bare the risks of an adequate pension income, with a sense of ownership” according to Solange Bernstein, expert on the Chilean pension reforms from the Inter-American Development Bank. The basic economic idea is that individual welfare increases from having more choice in one’s own investment strategy, contribution level and pension provider.

‘the ‘freedom to choose’ is no remedy for risk reallocation if people cannot bear those risks’,

is another insight from the experts who have dealt with or studied similar reforms. The Chilean pension reforms are often used as an inspiring example of how reforms could work out well for the pensioners. Solange’s insights however, are full of warnings, such as: compulsory saving is not including the self-employed. Chris Curry adds that one should think through the processes that individuals go through in their daily lives. There is a natural moment when the self-employed might be most

tempted to save for their pension. That is for example when they fill out their tax forms and get a rebate. If the online tax forms would include the option of putting aside some of the rebate for pension saving right away, it might trigger the self-employed to do so.

This is what we call a nudge to change individual’s behavior. But nudges do not always work out as planned. Strikingly, offering default investment packages to Chilean participants along with the introduction of more freedom of choice, did not nudge 40 percent of the participants into the default. Those who actively switched out of the default option where in 82 percent of the cases worse off than they would have been in the default option. Here we find another valuable lesson from the Chili experience:

‘allowing people to choose their own investment risks is going to make them worse off and nudging alone will not undo the damage’.

Overall, Chilean reforms did not increase the level of pension adequacy. The replacement rate has decreased rather than increased after the reforms. Solange’s findings are indeed suppor-ting the insight that is also brought in by Chris Curry from the Pensions Policy Institute in the Uk:

‘Dont allocate risks with people who can’t bear them’

But,

‘if you go ahead anyway, make sure you know what you’re doing it for. it might get messy and you will need consensus on that being worth everyone’s while’

With great amazement, Chris Curry found out that the British government had no other aim in mind for introdu-cing freedom of choice than the notion that: ‘whom other than people them-selves know best what to do with their money?’ “plenty of people” according to Chris, causing a laughter among the participants.

Alwin Oerlemans from APG confirms that people often don’t behave in ways that are seen as economically optimal. “Surveys show that contrary to what is expected, young people tend to invest more safely than older people. It would be better for them to do it the other way around”

An international comparison from Mercer’s international consulting group presented by Norman Dreger reveals that on a superficial level, some might feel that there is no clear reason why reforms to the Dutch pension system are needed. The Dutch pension system is scoring highest on almost all of Mercer’s pension dimensions in terms

of adequacy, sustainability and inte-grity. However, part of the strength of the Dutch pension system has been the ability to make changes to reflect the changing macroeconomic environ-ment. Pension adequacy is not the only dimension to look at, according to Norman. A system’s sustainability is another aim and often a tradeoff with adequacy. Sustainability is challenged by a number of developments such as ageing, longevity and old-age poverty. For future pensioners, benefits are no longer guaranteed. This notion is particularly dissatisfying to people in countries which have had very ade-quate systems in the past. It’s what economists call loss aversion.

‘helping people to manage their risks requires a broad view on financial planning’

APG’s Alwin Oerlemans reveals the plans that APG is developing on broad financial planning. Alwin states that because career choices, housing and pension savings are strongly intertwined from an individual’s perspective, and because uncertainty is increasing in all dimensions, people need help in their life-time financial planning. Pension providers are ideally equipped to provide this advice at very low or no costs.

This broad and all-encompassing approach fits well into the advice of Chris Curry: because reforming a pension system takes decades rather than years, a broad consensus on each reform and instrument are crucial for success.

Finally, Johan Barnard of APG presen-ted what at first seemed to be an inside view on an outside European plan and not vice versa. As his presen-tation continued his message for the inside became clear to me, which is:

‘beware of the european commis-sion’s action plan for a Pan euro-pean Pension Plan as Gresham’s law might apply where bad pensions drive out good ones’

The plan is to initiate a market for a very simple personal pension to those

Europeans that are foreseen to have inadequate pensions in the future. By creating one market for this personal pension plan the Commission also aims to promote cross-country labor mobility and to channel pension savings into long-term investment to help initiate a European Capital Union. According to Johan Barnard to aim for multiple goals with one instrument is problematic, and a wrong ordering of these aims may lead to less good pensions drive out better ones..

Everybody agrees, perhaps also with an eye on the drinks that await us. But before we leave the room, Michiel van Leuvensteijn, who has initiated the dialogue meetings and the articles in this magazine, is being greatly thanked for his efforts in the past years.



©2016 aPG Group n.v.

This is a publication of APG Group N.V. (APG)

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To the extent required by them, all the above reservations are also made on behalf of the authors concerned.

ColophonPension Doc. is a publication of aPG intendedfor policy advisers, politicians, managers andresearchers.

editorialGroup Strategy & [email protected] Communications & Branding

Photographyi-stock: pp. 16, 37

illustrationsrhonald Blommestijn: pp. 2-3, 6-7, 24- 25DeLeeuwOntwerper(s): pp. 8-14, 18-19, 22, 30-31, 34, 37, cover

subscritionPensionDoc. is a free publication of APG.For registrations, cancellations, or changes of address,please contact [email protected] call +31 (0)20 583 35 34For a digital version of Pension Doc., see www.apg.nl

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